Markets hope for Fed boost to U.S. economy

The Federal Reserve is widely expected to offer up some new stimulus for the sagging US economy when it closes a key policy meeting Wednesday, but many question whether it will do much.

The two-day meeting of the central bank’s Federal Open Market Committee might move to further press down long-term interest rates, in hopes of prodding cash-rich banks to lend and companies to invest despite gloomy economic forecasts.

But worries by some FOMC members over rising prices was expected to temper any strong moves, including a renewed “quantitative easing” program that would inject billions of dollars of liquidity into the economy.

Modest moves could disappoint markets hoping for a big move — but would appease those fearful that the Fed could deadlock over how it should deploy its limited bag of monetary tools.

“The Federal Reserve’s options are limited, but not exhausted,” said economist Joshua Feinman at Deutsche Bank.

There were no hints from the Fed itself Tuesday on the direction of the discussions.

The FOMC’s last meeting on August 9 produced a pledge to keep interest rates and ultra-low levels for two more years, an effort to boost the confidence of investors who might be able to boost the economy and create jobs — the biggest concern for the US government at the moment.

But, uncommonly, three of the panel’s 10 members dissented on that move. All three are understood to have greater worries about unleashing high inflation than boosting economic growth.

Now though, after another month of evidence showing the economy stalling, and with unemployment still stubbornly over 9.0 percent, the growth and jobs agenda could be the main shaper of any Fed decision.

“Given the weakness of the incoming economic data, the Fed is now almost certain to do something, but exactly what is still not entirely clear,” Paul Ashworth of Capital Economics said.

Few expect a revival of the “quantitative easing” program. The previous “QE2″ operation, which expired at the end of June, poured $600 billion into the economy over six months, forestalling deflation but failing to generate self-sustaining economic growth.

That would likely be too inflationary for the “inflation hawks” to accept, economists said.

A new QE-type program “does not look like a realistic option” for the meeting, said Jan Hatzius of Goldman Sachs.

Most expect a hopefully stimulative economic measure known as “Operation Twist,” a 1961 bond-buying tactic to lower long-term interest rates, named after the popular rock-and-roll dance of the time.

The “Twist” would be that the Fed shifts its huge holding of short-term US bonds to long-term bonds, with the aim of pressing down long-term rates, to further encourage bank lending to companies and corporate investment.

Another possibility is to reduce to zero the interest the Fed pays on the excess reserves commercial banks deposit with it — another incentive for them to take risks and lend it out to higher-paying private borrowers.

Thirdly, the Fed could get explicit over its targets for its two key mission points, inflation and unemployment.

That is, it could be clearer at what levels a change in policy would be necessary or desirable — most importantly at what point of inflation interest rates should be raised.